KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Policy Study KOR A Study on Property Tax Incidence

This study examines the incidence of property taxes, focusing on whether the property tax, which is levied on the property owner when the owner and the user are different, is passed on to the user. If the tax is borne by the owner, it acts as a capital tax; if passed to the user, it functions as a consumption tax. Additionally, if the revenue from the tax is used to improve local environments, it could be considered a benefit tax.

Through empirical analysis, the study explores how changes in the comprehensive property tax system affect housing rental prices. The findings show that these changes have little impact on the rental market. No evidence was found to suggest that rental prices increase as the publicly assessed value rises near the taxable threshold. Moreover, using a difference-in-differences method to compare rental prices before and after the policy change, the analysis confirms that the strengthened system did not lead to higher rental prices for properties subject to the tax.

In conclusion, the results suggest that the tax is best viewed as a capital tax. Taxing housing assets may reduce investment and hinder the efficient allocation of capital. Since South Korea's property tax level is in line with the OECD average, it is important to minimize changes to the system, analyze its effects, and then proceed with reforms.

Summary

Policy Study KOR Economic Effects of Capital Gains Tax on Housing

This study examines the economic effects of South Korea’s capital gains tax reforms on housing, focusing on the lock-in effect ― a contraction in housing transactions following higher tax rates. In 2017, amid a prolonged housing boom, the government raised capital gains tax rates for multi-homeowners. Analysis of transaction volumes and prices around the announcement and implementation reveals a pre-reform surge in sales and gifts, followed by a post-reform decline. A temporary suspension of the tax in 2019 again triggered a short-term uptick in transactions during the grace period.

These findings suggest the tax policy failed to achieve its intended goal of stabilizing the housing market. The lock-in effect, compounded by low policy credibility, likely contributed to diminished public trust in housing policy. Moving forward, housing tax reforms should be anchored to fundamental taxation principles, prioritizing efficiency and equity while promoting system stability to ensure predictable obligations for taxpayers and bolster confidence in the housing market.

Summary

Policy Study KOR Tax Revenue Structures in an Aging World: International Comparisons and Policy Insights

This study aims to foster informed public discourse on inevitable tax increases in response to the substantial fiscal pressures of population aging. Chapter 2 examines how major advanced economies that experienced population aging earlier than South Korea mobilized financial resources during this demographic shift. Chapter 3 empirically analyzes tax reform strategies that reduce revenue volatility, support economic growth, and promote equitable taxation. The findings support strengthening value-added tax (VAT) and personal income tax―a widely endorsed approach mong tax experts and implemented in major advanced economies. However, Korea has limited experience with universal tax increases and faces considerable public resistance to such measures. To assess whether these concerns are based on empirical evidence, Chapter 4 examines 150 cases of VAT or personal income tax increases implemented in major advanced economies. The findings reveal that only 20% of these tax increase cases resulted in a change in government. Finally, Chapter 5 argues that concerns over political repercussions should not preclude universal tax increases as a key policy option for enhancing the sustainability of public services. The study also emphasizes two prerequisites for the government to address before initiating public discourse on tax increases: earning public trust in the efficiency and effectiveness of fiscal expenditures through structural reforms and improving the general public’s fiscal literacy.

Summary

Research Monograph KOR Reconsideration of Tax and Fiscal Policies after COVID-19

The purpose of the study is to put forth tax and fiscal policies necessary to make worsened fiscal conditions after COVID-19 more constructive and sustainable. We first present the long-term fiscal baseline projections until 2060 and suggest four policy measures that could enhance the future fiscal space of Korea. Then, we analyze the possible positive impact of intangible investment other than R&D on improvements in total factor productivity (TFP), which could result in a natural increase in government revenues through economic growth. Finally, we also empirically evaluate the pros and cons of several types of fiscal rules and suggest rules for spending that could be one plausible alternative considering the current policy environment in Korea. The main findings and policy implications are summarized as follows.

In chapter 2, we present policy measures needed to achieve the long-term fiscal policy goal announced by the Korean government in September 2020, the government debt-to-GDP ratio of 81.1% in 2060. Before delving into specific measures to enhance fiscal space, we look at the baseline debt-to-GDP ratio for 2060, projected at 144.8%. Among three risk factors considered in this study, the failure of discretionary expenditure control was most detrimental to future fiscal conditions. If the discretionary expenditure ratio to GDP is kept at 14.7% until 2060, the debt-to-GDP ratio is expected to add 86.1%p compared to the 2060 baseline.

Even if these risk factors are not realized and remain as the assumption of the baseline outlook, the 2060 debt-to-GDP ratio far exceeds 81.1%, the government's long-term fiscal goal. The analysis finds that the government debt ratio in 2060 could be reduced to 87.6% by reforming local education financial grants, additional control of discretionary expenditures, raising effective tax rates of income and value-added taxes, and reducing tax expenditures.

Over the past two decades, the Korean economy has experienced low economic growth despite the persistent expansion in traditional inputs, capital, and labor. In this circumstance, TFP has come into the spotlight as a new engine to revitalize economic growth, which could enhance government revenues and fiscal sustainability.

In chapter 3, we investigate the determinants of TFP, focusing on the role of intangible assets on firms' productivity. Exploiting firm-level data from Kisvalue, we first estimate the TFP of sample firms by applying Olley-Pakes (1995) method and examine the determinants of TFP. Our findings show that other intangible assets such as patents and copyrights play a more decisive role in improving the productivity of firms rather than R&D investment. This tendency appears to have strengthened after the global financial crisis. Thus, our results indicate that Korean firms have not achieved effective allocation among their investments in intangible assets. In this sense, we suggest the Korean government seriously consider re-designing the institutional system to encourage firms to diversify their investment in intangible assets.

In chapter 4, several empirical analyses were conducted to understand the expected positive and negative effects of the controversial introduction of the fiscal rules to enhance fiscal soundness. An international panel analysis confirmed that introducing such rules could increase fiscal space mainly by reducing the intrinsic interest cost of the existing national debt. On the other hand, it also confirmed concerns that the pro-cyclicality of fiscal spending could increase if fiscal resources were insufficient, especially in developing countries, or if applied excessively multi-layered fiscal discipline. In addition, it was shown that the introduction of the spending rules regulating the total amount of fiscal spending significantly lowered the probability of occurrence of a systematic banking crisis.

In Korea, it is difficult to set realistically achievable national debt and fiscal balance ratios due to rapid changes in demographic and industrial structure. Given this reality, the government needs to prepare reasonable fiscal rules for the growth rate of government spending and the ratio of expenditure to GDP in order to reduce the excessive burden on the national economy due to fiscal uncertainty. Although the current level of the national debt is relatively low, it is desirable to manage its increasing rate by applying reasonable fiscal expenditure rules coupled with the appropriate fiscal balance rules when a rapid increase in national debt raises concern.

Summary

Policy Study KOR Income Mobility in Korea and Policy Implications

This study examines the limitations of income mobility indicators, which are mainly used in existing studies, and presents the results of applying the analysis method of Krebs et al.(2019) to Korean survey data. The temporary income shock on residual income, which is not explained by individual characteristics such as education, job career, age, and so on, increases income mobility, but has a small impact on social welfare. On the other hand, the faster the permanent income shock disappears, the faster the difference between the residual income of low- and high-income earners decreases, and the higher the income mobility and social welfare. Of course, the greater the variance of the initial permanent income variance, and the greater the magnitude of the permanent income impact afterwards, the higher the income mobility but the lower the social welfare. In addition, 80 percent of one-year short-term income mobility was analyzed due to temporary shocks, including measurement errors, so it seems desirable to analyze income mobility analysis at least over the span of three years.

Korea’s income mobility itself is analyzed to have increased further since around 2012, but social welfare has decreased. This implies that the analysis of income mobility indicators themselves should not be the sole purpose of analysis. In order to increase social welfare as well as increase income mobility, it seems necessary to reduce the persistence of permanent shocks and reduce the size of external economic shocks that result in changes in residual income.

Even if income mobility is slightly reduced after tax, personal income tax acting as a buffer that can alleviate the size of income shocks increases social welfare. In this regard, it seems necessary to impose more burden on high-income earners of health insurance premiums and national pension premiums. the government cash transfer, which is being provided for the purpose of protecting the vulnerable, rather significantly reduced income mobility and social welfare, which seems due to the sharp increase in the portion of government cash transfer given to the top 40 percent earners comparing to 2007-2008. It is necessary, through further review, to be more careful in setting the beneficiaries of policy measures so that government cash transfer can be concentrated on the vulnerable.

The new income mobility analysis method introduced in this study can be applied to the study for income tax reform through a more detailed analysis for each component of income tax. However, this will be possible only when the National Tax Service has wider access to detailed items on individual income tax return form. In addition, the portion of government cash transfer given to high-income earners is also deemed for further review using administrative data.

Summary

KDI FOCUS Improving Tax Expenditure: From the Perspective of an Integrated Fiscal System

□ Designed to support specific groups and fields, tax expenditures are rapidly expanding, independently from direct expenditures with identical policy goals. However, without an integrated monitoring process, the interconnection between the two can sometimes weaken the goals they both seek. As such, a database that covers all tax and direct expenditures should be built and used to comprehensively review the effectiveness of the programs.

- Policies supporting diverse groups and fields are expanding in the form of tax expenditures at a considerable scale, particularly in social welfare, industry, SME, and the agriculture and fisheries sectors.

- The EITC was expanded without being reviewed for its effectiveness, and the CTC was adopted in 2015.

- The EITC, a tax expenditure and the NBLS, a direct expenditure, are both designed to support the income and self-reliance of low-income households, but the interconnection between the two creates an income reversal wherein more work leads to less total income.

- A 100 won increase in earned income reduces benefits by 125 won in benefits, leading to a 25 won decrease in the total post-tax income.

- Accordingly, these expenditures may be ineffective in inducing work and self-reliance of low-income households, contrary to the intended policy goals.

- Respective tax programs that are fragmentarily evaluated and revised in line with their respective goals could distort the whole tax structure.

- The tax reform in 2013 was intended to improve tax equity, but failed to reflect a comprehensive perspective within the overall tax system. As a result, the proportion of exempt individuals soared to 48% and went against the basic direction of governmental efforts to counter the low birth rate.

- To properly evaluate tax expenditure programs, relevant information needs to be provided in a timely manner.

- A database on tax and direct expenditures that seek identical policy goals should be built and the information must be interconnected.

- A structure that comprehensively examines both tax and direct expenditures should be strengthened along with an effectiveness check on respective tax expenditures.

Summary

Policy Study KOR Analysis on Macroeconomic Effects of Tax System Change: A General Equilibrium Approach

This paper analyzes macroeconomic effects of tax system change based on a calibrated dynamic stochastic general equilibrium model. Based on the IMF’s Global Integrated Monetary and Fiscal (GIMF) basic model, the model includes a pension module and considers four countries to reflect the future trend in age-related government expenditure and the trade structure of the Korean economy. Key parameters were set based on the latest statistical data and previous research results.

We examine macroeconomic effects of three types of tax system change: the temporary tax reductions to boost the economy, the permanent tax increments to finance the expected age-related or pension expenditure, and realistic tax policy changes in recent years or in the near future of home and foreign countries.

These quantitative exercises give us the following policy implications. First, the tax cut policies for stimulating the economy are less effective than the fiscal spending expansions. Temporary tax reductions may be at best complementary to other government spending policies firming up the policy direction of government in exceptional circumstances such as the economic crisis. Second, we need to start discussions on the structural change of the tax system to finance the long-term age-related spending. The consumption taxes are the most efficient policy measures minimizing the reduction in aggregate output but there is a risk of sparking political opposition because the consumption taxes tends to be regressive and the private consumption will sharply shrink at the time of tax hike. Third, the domestic spillover effects of major countries' tax policies are relatively large due to the small open economy characteristic of Korean economy, so it is necessary to consider preemptive policy responses to mitigate or reinforce the domestic ripple effects.

Summary

KDI Policy Forum Impact of Corporate Tax Cuts on Corporate Investment

□ There has been growing public support for a tax hike as corporate investment remains stagnant despite the recent cut in the corporate tax rate. Accordingly, this study aims to closely examine the impact of the corporate tax rate on investment.

- Managerial decisions, including those on investment, are based on a diverse range of factors, encompassing not only the corporate tax rate but also financial conditions and investment uncertainties. As such, corporate characteristics must be controlled, when possible, before estimating the impact of corporate tax change on investment.

□ An empirical analysis found that Korea’s listed companies expand their investment significantly when the corporate tax rate is reduced.

- For the robustness of the analysis results, this study adopted various models and methodologies to analyze listed companies in 2002-2014 and found that a 1%p cut in the average effective corporate tax rate caused the investment rate to increase by 0.2%p.

- In particular, it can be assumed that such an increase in investment may have been higher if the managements‘ tunneling activities were curtailed.

·An analysis, using a structural model, revealed that in Korea, management sought private interests nine times more than their counterparts in the US, diminishing the effects of a tax cut by roughly 28% in the short run.

□ Therefore, the government must take a cautious approach when increasing the corporate tax rate, and also strengthen the internal and external monitoring and supervision of management to enable companies to make reasonable investment decisions.

Summary

Policy Study KOR The Impact of Tax-regime Change on Investment and Dividend Policies

This paper shows that while the Korean corporate tax rate is relatively low compared to other major economies, the ratio of corporate tax income to GDP is relatively high. In particular, as the dividend capacity of listed companies, i.e. profitability and cash-flow, deteriorates the corporate investment in Korea could shrink on the reduction in the dividend tax rate.

In addition, it is shown using a theoretical model that the reduction on the corporate tax rate affects the investment and dividend policy the most by allowing managers to take advantage of or Tunnelings from the corporate cash holdings. However, the dividend tax cut expands the dividend income but has a negative effect on the whole economy. On the other hand, the impact of the corporate tax cut increases under corporate governance that does not have managerial Tunnelings because healthy governance without managerial private incentives reduces the relationship between investment and cash equivalents, and dividends and cash equivalents. Thus, policy makers should focus on improving the fundamental business environment rather than short-term stimulus such as a temporary corporate income tax cut or dividend tax cut.

Finally, this paper investigates the impact of financial variables and corporate tax cuts on dividend and investment policies by using a reduced model. The empirical results show that corporate cash holdings, cash flow, sales growth and average effective tax rate influence corporate investment. Also, it is shown that the dividend payout ratio at the previous period, cash flow, and average effective tax rate affect the dividend payout ratio

Summary

Policy Study KOR Tax Revenue Forecasts with Possible Structural Changes

During the past three consecutive years, over-estimations in forecasts of tax revenue have led to revenue shortfalls. These developments have motivated this study, which examines the current practices in tax revenue forecasting and the existing literature, and conducts tests for the presence of possible structural changes in tax revenue and other relevant time series. We then comparatively evaluate the performance of each forecasting model to select the best- performing models by tax item, using these to make 5-year forecasts for the revenues of the national tax and other key tax items.

While differences in political characteristics and budget processes across countries does not allow for a direct comparison, We find that the forecast errors for Korea’s tax revenue over the past decade are not particularly serious in terms of bias or instability when compared to that of other countries. Nevertheless, it is evident that the average bias has been widening recently, while the tax revenue has been overestimated by nearly 5% during the past three years.

To avoid the systematic over-estimation of tax revenue, it is important to consider the slowdown of tax revenue growth. We check the validity of the log linear system and strongly reject the log linear system. There is a clear sign of structural change in the linear trend or nonlinear trend in national tax revenue series and related macro series. However it is uncertain what kind of nonlinear trend is appropriate for the purpose of forecasting because several nonlinear specifications give similar in-sampling fit but make quite different out-sample forecasts.

We incorporate the element of structural breaks or nonlinear trend in making our forecasts through employing dummy variables, cubic spline models, exponential smoothing models, piecewise regression models combined with structural change tests, as well as a combination of the forecasting models. Because of the characteristics of each tax item’s data and the differences in the associated tax systems, different models were found to perform better for each tax item. For example, piecewise regression and exponential smoothing are effective for national tax revenue forecasting but vector autoregressive model and error correction model with dummy variables are best-performing for corporate tax revenue forecasting.

Due to the high possibility of recent structural changes in the national tax and corporate tax, the effects of such changes must be examined more closely. As there are still uncertainties regarding the existence of recent structural changes and their effects, using exponential smoothing models which take account of such uncertainties or a combination of models may contribute to gains in predictive power.

Along with the aforementioned technical treatment of tax revenue forecasting models, we would like to point out the necessity for a review of when the forecasts are made during the budget process. In addition to the fact that the circumstances in both the domestic and international economy, within which taxation must take place, have become increasingly complex, there have been calls for more accurate revenue forecasts to secure fiscal soundness. These developments suggest that we must reconsider whether it is adequate to present the 1-year horizon forecast (for individual tax items) when the budget is proposed to the National Assembly, and the 5-year horizon forecast (for the national tax) for the National Fiscal Management Plans. Rather than keeping revenue forecasts a one-off affair prior to the drawing up of the budget bill and its deliberation, making it an ongoing effort throughout the budget process and linking it to the next year’s budget process will allow for better amendment of errors and overall improvements in structural predictive power.

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